By Jacob Sonenshine
Small market capitalization stocks have jumped, but the good times won't continue to roll for all of them.
The S&P 600, which has an average market cap of $3 billion, is up 16% this year. It took several years, but the index finally reached a record close with the most recent high coming in at 1544 after the November election.
Investors bought up small-caps because of President-elect Donald Trump's policy proposals. Fiscal spending is expected to hit tens of billions of dollars annually.
That would boost the economy and the S&P 600, which is less weighted toward technology and more toward relatively economically-sensitive sectors such as financials and consumer discretionary. Tax cuts for companies that produce goods domestically would provide an especially large benefit to earnings for this index because it is fairly domestically-focused versus the more globally-exposed S&P 500.
But that is already reflected in the S&P 600's price level of just under 1510. The index hasn't hit a new high in weeks -- buyers have already loaded up.
About $30 billion has flown into U.S. small cap funds this year, on net, according to Bank of America. That is a record, and it is about triple last year's inflow. Not much more can go into this asset class -- not to mention that, since at least 2010, every year that follows a record inflow to small-caps sees a net outflow.
Right now "we don't have another catalyst, near term, to justify a continued rerating higher in small caps...into year-end," writes 22V Research's Dennis DeBusschere.
That lands small-caps in a place where they have to prove that next year's earnings will come in higher than what analysts currently model. The index's price level is now 17 times the current 2025 earnings, in aggregate, that analysts forecast, up from just over 14 times to start this year. That is still cheaper than the S&P 500's over 22 times, but the gap has narrowed.
Disappointments on earnings would drag the little guys lower. For smalls, "it will be a 'show me' story," DeBusschere writes.
So Barron's screened for S&P 600 names that look most likely to continue their rallies. We only wanted companies that have recently executed well, so we searched for those that have beaten analyst earnings estimates in at least seven of the past eight quarters. Of those, we wanted firms that can sustain high profit growth, so the screen included companies with at least 10% expected earnings growth in both 2025 and 2026. We also wanted stocks that aren't very expensive, so we only included those trading at multiples below the index's price-to-earnings ratio.
The screen turned up 23 stocks. They included $2.7 billion online lender Enova International, $1.5 billion Allegiant Travel, $2.1 billion software-as-a-service company LiveRamp Holdings, and $6.2 billion mortgage servicing company Mr. Cooper Group.
Another company on the list is the $3.2 billion fashion brand owner Steven Madden. It trades at 15.3 earnings and the company has surpassed expectations in seven of the past eight quarters.
Management said on its third-quarter earnings call it is on track to end this year with midteens percentage growth in international sales, which accounted for a fifth of the company's roughly $2.3 billion of total revenue in the past 12 months, according to FactSet. The company is ramping up its business in Europe, where it is taking market share.
That type of growth can unlock just over 5% total sales growth annually over the next two years to $2.49 billion in 2026, analysts forecast. If product costs and marketing expenses don't balloon, EPS can grow about 12% annually.
Tripadvisor is also on the screen, with a $2 billion market cap. It trades at 10.8 times earnings and has beaten earnings in seven of the past eight quarters.
While it competes against travel giants Booking Holdings, Expedia Group, and Airbnb, it has still seen sales growth every year since 2020, even after the initial stages of the Covid-19 recovery.
The company sees most of its just under $2 billion in annual sales from hotel and airline advertisers on its website. It also derives revenue when users reserve tables at restaurants. The broader travel market is over a trillion dollars yearly, and just grabbing a little bit of market share each year sparks strong sales growth. To aid further growth, Tripadvisor has already added an artificial intelligence assistant to its website, which can immediately offer spots and activities and answer user questions.
Analysts expect revenue to grow almost 7% annually to just over $2 billion by 2026. Management may have to increase marketing dollars, but analysts don't expect exorbitant spending. Margins can rise and adjusted EPS can rise 14% annually over the coming two years.
These stocks are better candidates to continue rallying than most small-caps.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
December 10, 2024 00:01 ET (05:01 GMT)
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